Creating an Even Playing Field: State Sales Tax and Internet Transactions

Brenton Conrad*

In 2016, South Dakota enacted emergency legislation requiring out-of-state businesses to pay South Dakota sales tax for any in-state internet purchase, claiming that the loss of revenue from a sales tax was “causing revenue losses and imminent harm . . . through the loss of critical funding for state and local services.”  South Dakota v. Wayfair, Inc., 138 S. Ct. 2080, 2088 (2018) (quoting S. 106, 2016 Leg. Assemb., 91st Sess. (S.D. 2016)).  Pursuant to this Act, sellers that delivered more than $100,000 of goods or completed 200 or more transactions in the state annually were required to collect a 4.5 percent sales tax on all purchases within South Dakota.  Id. at 2089.  As a result, South Dakota filed a declaratory judgment action against Wayfair, Inc.,, Inc., and Newegg, three companies that had no physical presence in South Dakota, and did not collect any South Dakota sales taxes, but nonetheless met the requirements of the 2016 South Dakota Legislature.  Id. at 2090.  The South Dakota Supreme Court ruled in favor of the Defendants by citing to the U.S. Supreme Court decision in Quill Corp. v. North Dakota, which enforced the “physical presence rule.”  Id. at 2091.  Ultimately, the 2016 Act was struck down by the South Dakota Supreme Court as unconstitutional.  Id. at 2091.

The question of mail-order transactions and state sales taxes was first addressed by the Supreme Court in 1992, when the Court held in Quill Corp. v. North Dakota that a state may not subject a business to a state sales tax on mail-order transactions if that business has no physical presence within that state.  Quill Corp. v. North Dakota, 504 U.S. 298, 315 (1992).  At the time of that holding, mail order sales generated approximately $180 billion nationwide.  Id. at 329.  This ruling provided internet services that deliver goods nationwide with a competitive edge against companies headquartered in a state, which are required to pay that state’s sales tax.  Adam Liptak et al., Supreme Court Widens Reach of Sales Tax for Online Retailers, N.Y. Times (June 21, 2018),  It is now estimated that remote sellers generated a half-trillion dollars in 2017, leaving billions of dollars in possible state sales taxes in the pockets of these companies instead of the hands of state and local governments.  Id.

After the South Dakota Supreme Court ruling, the U.S. Supreme Court granted a petition for certiorari filed by South Dakota, and ruled in favor of striking down the physical presence rule on June 21, 2018.  Wayfair, 138 S. Ct. at 2099.  In allowing the enforcement of South Dakota’s Act, the Supreme Court reasoned that due to the growth of internet sales, a nexus exists between these internet retailers and the states where their products are purchased.  Quill, 504 U.S. at 298.  The Supreme Court further held that the Quill holding is no longer applicable to the current economy.  Id. at 2096–98.  Additionally, the Court felt that the Act protects small business start-ups by not requiring sales taxes unless the business has $100,000 in sales or over 200 transactions, and by barring the tax from being applied retroactively.  Id. at 2098.  Because “South Dakota is one of 20 States that has adopted the Streamlined Sales and Use Tax Agreement,” the Act does not appear to violate the Commerce Clause.  Id. at 2099–2100.

However, while states may seek to rush and change their current tax practices to increase the sales tax on internet sales after the ruling in Wayfair, there are those who foresee several potential issues with states applying the holding of the Supreme Court.  Zach Gladney & Charles Wakefield, Insight:‘Wayfair’: What are the Practical Retroactivity Concerns?, Bureau Nat’l Aff. (July 19, 2018),  One concern involves the ruling of the Supreme Court in Complete Auto Transit, Inc., where the Court held that a sales tax does not violate the dormant commerce clause if “the tax is applied to an activity with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State.”  Gladney & Wakefield, supra; Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).  After the ruling in Wayfair, states run the risk of causing double taxation to both the buyer and seller of goods, making such a tax unconstitutional under the ruling of Complete Auto because it would effectively limit interstate commerce.  Gladney & Wakefield, supra.

Additionally, a problem arises when attempting to retroactively apply a tax to transactions that occurred prior to the Court’s judgment.  Id.  In Chevron Oil Co. v. Huson, the Supreme Court established a three-prong test for determining whether a decision should be applied retroactively.  Chevron Oil Co. v. Huson, 404 U.S. 97, 106–07 (1971).  The third prong of this test requires a court to determine whether “equities cut in favor of prospective application.”  Gladney & Wakefield, supra.  After Wayfair, retailers may contend that taxing them for past transactions without any ability to collect the tax from previous purchasers of their goods imposes an inequitable burden on them.  Id.  They may also demand a prospective application of the ruling instead.  Id.

As a result of Wayfair, South Dakota may begin to collect the tax on online purchases within 30 to 90 days, while other states, such as North Dakota, have already enacted similar legislation.  Liptak, supra.  While this does give states access to upwards of thirty billion dollars of sales tax revenue collectively, there still exists the limitation of a state’s sales tax not being overly complicated as to burden interstate commerce.  Joseph Bishop-Henchman, Supreme Court Decides Wayfair Online Sales Tax Case, Tax Found. (June 21, 2018),  Thirty-one States, including South Dakota, currently have laws taxing internet sales.  Id.  However, most of these laws are not as complex as South Dakota’s recently upheld Act.  Id.  So long as internet sales continue to be the preferred method of shopping for many individuals, the amount of taxes that retailers (and thus consumers) will pay depends on how state and federal legislatures respond with changes to their tax codes in the following months.

*Brenton Conrad is a second-year law student at the University of Baltimore School of Law, where he is a staff editor for Law Review. Brenton is also a member of the 2019 Tax Moot Court Team, Event Coordinator of the Entertainment and Sports Law Society, and a member of the Royal Graham Shannonhouse III Honor Society. Brenton will be spending his 2019 summer with Council Baradel as a law clerk.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: